Some Simple Tests of the Globalization and Inflation Hypothesis

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Abstract:

This paper evaluates the hypothesis that globalization has increased the role of international factors and decreased the role of domestic factors in the inflation process in industrial economies. Toward that end, we estimate standard Phillips curve inflation equations for 11 industrial countries and use these estimates to test several predictions of the globalization and inflation hypothesis. Our results provide little support for that hypothesis. First, the estimated effect of foreign output gaps on domestic consumer price inflation is generally insignificant and often of the wrong sign. Second, we find no evidence that the trend decline in the sensitivity of inflation to the domestic output gap observed in many countries owes to globalization. Finally, and most surprisingly, our econometric results indicate no increase over time in the responsiveness of inflation to import prices for most countries. However, even though we find no evidence that globalization is affecting the parameters of the inflation process, globalization may be helping to stabilize real GDP and hence inflation. Over time, the volatility of real GDP growth has declined by more than the volatility of domestic demand, suggesting that net exports increasingly are acting to buffer output from fluctuations in domestic demand.

Keywords: inflation, globalization, Phillips curve

JEL classification: C22, E31, F41

I. Introduction

The past several years have seen a sharp escalation of interest
in globalization and its effects on all aspects of economic life.
There is no single definition of globalization, but most observers
define it as the increasing international integration of national
markets, including for goods, services, capital, and labor
(Frankel, 2006). Among the areas where globalization is thought, at
least by some, to be exerting increasing influence is the behavior
of inflation.

In the standard view, inflation is characterized primarily as a
function of domestic factors such as aggregate demand, wage
behavior, productivity, inflation expectations and, influencing the
balance between all of these factors, national monetary policy. Of
course, some external shocks, such as to import and energy prices,
are also thought to affect inflation, but perhaps to a less
fundamental extent. More recently, some observers have suggested
that globalization is diminishing the role of domestic factors in
the inflation process and elevating the role of global
developments. Such a shift, as one observer puts it provocatively,
``makes a nonsense of traditional closed-economy models used to
forecast inflation, which assume that firms set prices by adding a
mark-up over unit costs, with the size of the margin depending on
the amount of slack in the economy'' (The Economist, September 14,
2006).

The extent to which globalization has replaced domestic with
international factors as a primary determinant of inflation is the
subject of active debate. Borio and Filardo (2006) argue that ``the
relevance of a more `globe-centric' approach is likely to have
increased as the process of integration of the world economy has
gathered momentum, a process commonly referred to as
`globalization'. (Page 1) In contrast, Ball (2006) writes ``there
is little reason to think that globalization has changed the
structure of the Phillips curve or the long-run level of
inflation'' (Page 15).

Not surprisingly, monetary policymakers have taken an active
interest in the topic of globalization and inflation. Federal
Reserve Board Chairman Ben Bernanke notes that although
globalization has not ``led to significant changes in the process
that determines the U.S. inflation rate... effective monetary
policy making now requires taking into account a diverse set of
global influences, many of which are not fully understood''
(Bernanke, 2007). Federal Reserve Bank of Dallas President Richard
Fisher has argued that ``the old models simply no longer apply in
our globalized, interconnected and expanded economy... By spurring
productivity and fomenting tectonic economic changes, globalization
has acted as a tailwind for the Fed's--and other central
banks--efforts to hold down inflation'' (Fisher, 2006).1 This
sentiment is echoed in a recent statement by Lucas Papademos, Vice
President of the European Central Bank: ``One conclusion that has
some empirical support is that domestic inflation is no longer
determined predominantly by domestic demand and supply constraints,
but seems to depend more on the degree of global economic slack''
(2006, page 6). Donald Kohn, Vice Chairman of the Federal Reserve
Board, and Janet Yellen, President of the Federal Reserve Bank of
San Francisco, acknowledge that international forces likely are
playing an increasingly important role in the inflation process,
but conclude that domestic considerations probably retain a
predominant role (Kohn, 2006, Yellen, 2006).

One of the factors keeping the debate over globalization and
inflation alive is the absence of a wide range of compelling and
consistent empirical evidence. There has not been a great deal of
research on this topic, and what research there has been comes up
with conflicting findings. This paper contributes to the discussion
on globalization and inflation in two ways. First, we present a
comprehensive evaluation of the major channels through which
globalization may have changed the dynamics of inflation formation.
More specifically, we use Phillips curve equations, estimated over
the period 1977-2005 for 11 OECD economies, to assess three major
implications of the globalization and inflation hypothesis: (1)
measures of foreign resource utilization are affecting domestic
inflation, and to an increasing extent over time; (2) by the same
token, domestic inflation is becoming less sensitive to domestic
resource utilization, reflecting increased economic openness, and
(3) domestic inflation is becoming increasingly sensitive to import
prices. Secondly, in our research, we eschew complicated
econometric specifications in favor of standard, straightforward,
and transparent inflation models. This makes it less likely that
particular findings will owe to the particular econometric
specification used.

Before proceeding, several initial considerations should be
addressed. First, all papers on this topic generally acknowledge
that in the long run the rate of inflation is set by domestic
monetary policy. Accordingly, the argument that globalization has
affected the inflation process is an argument that applies in the
short to medium term, when shocks to prices or resource utilization
beyond a country's borders may temporarily influence a country's
domestic inflation rate. The resultant deviations of inflation from
the monetary authorities' desired rate should induce monetary
policy actions designed to return inflation to that desired rate
over the longer run. Moreover, the stance of monetary policy, by
influencing the behavior of inflation expectations, may also affect
how much inflation responds to shocks in the nearer term and how
quickly it recovers.2

Of course, some have argued that monetary authorities have been
willing to accommodate positive supply shocks, such as falling
import prices, over time as they have pursued a strategy of
``opportunistic disinflation'' (See Orphanides and Wilcox, 2002).
In the context of such a strategy, foreign shocks that depress
inflation arguably may have a persistent effect as long as
inflation exceeds the central bank's long-term objective. Also,
Rogoff (2003) argues that deregulation and international
integration have led to more flexible prices, so that inflation
surprises induced by monetary policy lead to more inflation and
less additional activity than in the past. Accordingly, in Rogoff's
argument globalization has led monetary authorities to target lower
inflation rates.3

Second, and as a related point, what allows the monetary
authority to unilaterally control the domestic inflation rate over
the longer term is a floating exchange rate. With fixed exchange
rates, a country necessarily will import both foreign inflationary
conditions and, with sufficient capital mobility, foreign monetary
policy as well. Floating exchange rates, in contrast, allow the
monetary authority to set interest rates independently of those
abroad. Moreover, as stressed by Kohn (2006) and Yellen (2006),
floating exchange rates insert a wedge between movements in foreign
prices and movements in the domestic-currency prices of products
imported from abroad. Thus, even if foreign economies are booming
and foreign price pressures are building, this need not lead to
price pressures domestically if the domestic currency is rising
against foreign currencies.

Finally, the topic of globalization and inflation embraces two
broad sets of questions. The first, which is the subject of this
paper, is whether globalization has changed the parameters of the
inflation process, so that domestic inflation is now more sensitive
to events beyond a country's borders and less sensitive to domestic
events. The second issue is whether globalization has led recently
to a decline in the inflation rates of industrial economies, in
particular because of the integration of low-wage, low-cost
countries-e.g., China, India, Eastern Europe-into the global
economy. China and other low-wage economies may have depressed
industrial-country inflation both directly, by reducing import
prices, and perhaps also indirectly, by influencing the process of
wage and price formation in the industrialized nations.4In any
event, quantifying this ``China effect'' involves different sets of
issues and data than analyzing the impact of globalization more
generally on the behavior and dynamics of inflation. 5

Therefore, to keep our research project focused, we confine
ourselves to assessing the evidence on how globalization in general
has altered the inflationary process. The plan of this paper is as
follows. Section II describes the ``globalization and inflation''
hypothesis in greater detail. Section III assesses the hypothesis
that foreign resource utilization is becoming more important to
domestic inflation. Section IV explores whether the flattening of
the Phillips Curve owes to globalization, and Section V assesses
whether, for the same reason, domestic inflation is becoming more
sensitive to import prices. Section VI addresses the stabilizing
effect of net exports as a possible consequence of globalization.
Section VII concludes.

II. The Logic of the Globalization and Inflation
Hypothesis

The premise that globalization is affecting the dynamics of the
inflation process rests on the view that, with national markets
increasingly integrated with each other, prices of goods, services,
labor, and capital increasingly can be arbitraged across national
borders. In consequence, rather than being set exclusively by
domestic supply/demand conditions within a given country, prices of
products and factor inputs are now influenced by supply/demand
conditions in global markets.

Equation (1), below, represents a very stylized Phillips curve
model of inflation, with inflation depending on inflation
expectations, the domestic (i.e., home country) output gap, and a
supply shock, the deviation of import price inflation from expected
CPI inflation.6 This equation has the feature that
consumer price inflation equals expected inflation when the economy
is operating at capacity and import price inflation moves in line
with consumer price inflation.7 The globalization and inflation
hypothesis has at least three implications for the inflation
process as summarized in this model.

YGAP +
- (1)

: CPI inflation

: CPI inflation expectations

: import price inflation

YGAP : output gap (actual output relative to potential)

First, and most obviously, as economies become more open and
more integrated with each other, it is logical that the direct
sensitivity of domestic inflation to movements in import
prices--represented by in equation (1)-should
increase. This may reflect increases in the direct effect of import
prices on the CPI, as the share of imports in consumption rises. It
may also reflect increasing indirect effects of import prices as
the share of imports in intermediate inputs rise, or as increasing
import penetration and competition lead to closer pricing of
similar categories of domestic and imported goods.

Second, some argue that if the globalization and inflation
hypothesis is correct, the standard model must be further augmented
by a term representing the extent of resource utilization in
foreign economies. This is indicated in equation (2), below. The
extent of global slack is posited to influence the extent of global
inflation, which in turn affects domestic inflation. Moreover, the
effect of foreign resource utilization on domestic inflation could
operate through factor markets as well as product markets: If
domestic wages rise too quickly, for example, this is more likely
to lead to domestic production cuts, the offshoring of jobs, and/or
a moderation of wage and price pressures when foreign labor markets
are loose than when they are tight.

YGAP + YGAP
(2)

YGAP : Foreign output gap (actual output
relative to potential)

Third, and by the same token, some reason that as globalization
proceeds and global slack becomes more important to domestic
inflation, measures of domestic resource utilization must become
relatively less important in determining domestic inflation. That
is, in equation (2) should decline.8

Some may protest that in an inflation model that incorporates
import prices, those import prices already encompass the behavior
of foreign resource utilization, and there is no scope for a
separate variable capturing global slack to influence domestic
prices. However, as Borio and Filardo (2006) point out, import
prices are not a ``sufficient statistic'' for the influence of
foreign markets on domestic prices. To begin with, import prices
capture only the cost of goods and services that are actually
imported; they do not capture the cost of other products that
potentially could be imported if domestic prices rise too far above
their foreign counterparts. (It is often suggested that the mere
threat of foreign competition may keep domestic prices--and
wages--in check.) Additionally, because many domestic firms sell
their products both in the domestic and foreign markets, the prices
they charge in domestic markets are likely to be influenced by the
prices they can charge in foreign markets; it is not clear how
correlated those latter prices will be with import prices. And, as
noted above, the effect of foreign resource utilization on domestic
inflation may operate through factor markets, wage differentials,
and the threat of offshoring rather than through import prices
alone.

There are several additional hypothesis for how globalization
may have altered the inflation process, although they are not well
supported by the data. First, some observers suggest that increases
in trade openness have led to increased competition and hence
reduced markups of price over cost (Chen, Imbs, and Scott, 2004).
However, as pointed out by Kohn (2006), the rise in profit rates in
recent years is inconsistent with the view that markups have
declined.

Second, and as a related point, some speculate that increased
trade, by exposing domestic producers to foreign competition, has
boosted productivity growth, and this could explain the downshifts
in inflation that occurred around the world in the 1990s. This
contention, too, is not well supported by the facts. Although U.S.
productivity accelerated in the 1990s, many other industrial
economies where trade openness rose experienced no corresponding
rise in productivity growth.9

III. The Role of Foreign Output Gaps

This and the following two sections describe research to test
the three predictions of the globalization and inflation hypothesis
described above: that globalization has increased the role of
foreign output gaps in determining inflation, that it has reduced
the role of domestic output gaps, and that it has increased the
sensitivity of inflation to import prices. In this section, we
address the first of these predictions. We begin by describing
previous research on this topic, and then present our own
results.

III.1 Previous research

Tootell (1998) estimates a standard Phillips curve model for the
United States over the 1973-1996 period and adds to the model
trade-weighted measures of foreign resource utilization-both
unemployment and the output gap-for six U.S. trading partners; he
finds no evidence that these measures affect U.S. inflation. Gamber
and Hung (2001) also estimate a Phillips curve model for the United
States over a similar period, 1976-1999. In contrast to Tootell,
they find that a trade-weighted average of capacity utilization for
35 U.S. trading partners positively and significantly affects U.S.
inflation. Wynne and Kersting (2007) also find some support for the
role of foreign resource utilization both when they extend
Tootell's model to the present, and when they examine the
correlation of foreign output gaps with detrended U.S. inflation.
However, Hooper, Slok, and Dobridge (2006) find that the aggregate
output gap for the OECD does not help explain U.S. inflation.

The strongest and broadest results for the role of foreign
resource utilization are in Borio and Filardo (2006). They estimate
Phillips curve models for 16 OECD countries (plus the euro area)
over 1985-2005. Both in equations for individual countries and for
a time-series/cross-country panel, they find the effect of
weighted-average foreign output gaps on domestic inflation to be
positive and highly significant, to generally exceed the effect of
domestic output gaps, and to be rising over time. These results are
robust to the inclusion of additional explanatory variables,
including import prices and unit labor costs.

However, other recent efforts to evaluate the role of foreign
resource utilization in a cross-country setting have not identified
significant effects. Pain, Koske, and Sollie (2006) find no role
for a global output gap in inflation equations for 21 OECD
countries estimated over 1980-2005. Ball (2006), estimating a panel
regression for 14 OECD countries over 1985-2005, finds the effect
of the foreign output gap on domestic inflation to be smaller than
that of the domestic output gap, to be of only marginal
significance, and to add little explanatory power.

III.2 New results

Because Borio and Filardo (2006) report results that strongly
support the role of foreign resource utilization, and because those
results have received widespread attention, we start by describing
their methodology and we then assess the robustness of their
results to alternative specifications of the inflation
equation.

Equation (3) below reproduces the Borio-Filardo paper's simplest
equation, a regression of de-trended four-quarter inflation in a
given country on a constant and that country's output gap. Equation
(4) adds as an explanatory variable a weighted average of the
output gap in that country's trading partners.

where

and where
is the headline CPI,
is the CPI excluding food and
energy, is the domestic output gap (actual
relative to potential),
is the foreign output gap (actual
relative to potential), and is an HP-filter
of variable .

The definition of the dependent variable--headline consumer
price inflation minus trend core inflation--is unusual. The
Borio-Filardo paper motivates this specification by suggesting that
trend core inflation may proxy for inflation expectations. In order
to assess the robustness of the Borio-Filardo results to changes in
econometric specification, it is important to first be able to
reproduce their benchmark estimates for a broad range of industrial
economies. We do so for 14 industrial economies, drawing on most of
the same data sources as the Borio-Filardo paper: inflation rates
and measures of domestic output gaps for some countries are drawn
from the OECD's Main Economic Indicators database, while output
gaps not available in that database are calculated as actual real
GDP relative to an HP-filter of real GDP.

Table 1 compares the BIS estimates of equation (3), which
involves only the domestic output gap, with our own estimates
(labeled FRB). With a few exceptions, our results are virtually
identical to those in the Borio-Filardo paper, indicating we have
successfully reproduced their initial results. Notably, the
coefficient on the domestic output gap is positive and
significantly different from zero in every country.

Table 2 compares the Borio-Filardo estimates of equation (4),
which includes their measures of foreign output gaps, with our own
estimates. Note that with the Borio-Filardo estimates, the
coefficients on the foreign output gaps are nearly always positive
and statistically significant, whereas their coefficients on the
domestic output gaps are now generally very small and
insignificant. As indicated by the columns labeled FRB, we are less
successful in reproducing the Borio-Filardo estimates of equation
(4) than we are with equation (3). We find the coefficient on the
foreign output gap to be positive and significant in only five of
the 14 industrial economies considered. This discrepancy reflects
the fact that our estimates of the foreign output gap for each
individual country differ from the Borio-Filardo estimates.
Although we likely use similar estimates of domestic output gaps
for each country, we weight them differently in constructing our
weighted-average foreign output gaps.10Accordingly, it is
apparent that the strong role for foreign output gaps identified by
Borio and Filardo is not robust to plausible alternative
definitions of those gaps.

That said, one of the five countries for which our results more
closely match the Borio-Filardo results is the United States. Does
this mean that inflation in the United States and these other four
countries is unusually responsive to foreign resource utilization?
We think not, and believe that the equation whose results are shown
in Table 2 is mis-specified. The last column in the table presents
a test for serial correlation of the errors, with the number
reflecting the probability that the errors are independent.11 It is
clear that the errors in all the equations are autocorrelated,
likely reflecting (1) the absence of lags of inflation in the
equations, and (2) the fact that the quarterly data on four-quarter
inflation rates lead to overlapping observations which induce
serial correlation.

To address these concerns, we re-estimate the inflation
equations using the more conventional specification described in
equation (5) below. The dependent variable is the inflation rate
alone; inflation rates are expressed as annualized
quarter-to-quarter changes in prices; and six lags of inflation are
added to the right-hand side of the equation. Additionally, we add
annualized quarterly percent changes in several control variables:
import prices excluding primary commodities, food prices, and
energy prices. (The Borio-Filardo paper also reports regressions
using similar control variables, and these do not affect their
results.) These variables are specified in relative terms, as
deviations from lagged CPI inflation. Finally (not shown in the
table), the regression model includes a constant and dummy
variables for influential changes in value added or excise tax
rates. (See Appendix Table 1 for details on these dummies.)

(5)

tax dummies,

where

and where is the import price (excluding
commodities), is the price of food, and
is the price of energy. We expect
0, meaning that an increase in
import prices relative to the CPI will, over time, trigger an
increase in the overall inflation rate. By the same reasoning, we
expect and .

Table 3 reports the parameter estimates for equation (5), using
both the same sample period as the Borio-Filardo paper, 1985Q1 to
2005Q4, as well as a longer sample for which foreign gaps are
available, 1977Q1 to 2005Q4. (Owing to the lack of import price
data for some countries, regression estimates are produced for only
11 countries rather than the 14 shown in Tables 1 and 2.) The
coefficient on the foreign output gap becomes small, sometimes
negative, and is not significantly different from zero in most
countries in the sample, including the United States. Additionally,
the equations now appear to be more properly specified, with serial
independence of the errors not being rejected for most of the
sample countries.

Thus, the surprising evidence presented in Borio and Filardo
(2006) paper for the role of foreign output gaps in determining
inflation apparently reflects the particular specification of Borio
and Filardo's inflation equation. Moreover, that specification
evidently leads to autocorrelation of the residuals. More standard
specifications of the inflation equation indicate little effect of
foreign output gaps for most of the countries we studied.

That said, it is worth noting that in the inflation equations
shown in Table 3, the domestic output gap is statistically
significant in less than half of the equations, and it is possible
that some other specification might cast the foreign output gap in
a more positive light. Some observers argue that in many countries,
inflation is influenced less by the level of the output gap than by
its change, the so-called speed limit effect. To address this
possibility, Table 4 re-estimates the equations shown in Table 3,
but includes as explanatory variables the quarter-to-quarter
changes in the domestic and foreign output gaps, as indicated in
equation (6) below.

(6)

tax dummies,

By and large, these speed limit effects are not significant, either
for the domestic or the foreign output gap.

An alternative possibility, attested to by the relatively low
significance of nearly all the explanatory variables in the
inflation equations, is that it is difficult to identify systematic
effects on inflation of any specific factor by analyzing national
inflation rates in isolation. Of course, differences in the
structural features of individual economies may lead to differences
in the inflation process, so estimating separate equations for each
country may best allow for the effects of inflation's determinants
to show through. However, a panel regression approach, in which the
data from different countries are pooled and thus more information
is used in estimating parameters, may have a greater chance of
identifying particular influences on inflation, including
globalization. Table 5a presents results of an inflation equation
estimated over the pooled data from all of the countries in our
sample. The equations are presented both with and without fixed
effects; those fixed effects take the form of country dummy
variables and quarterly time dummies. These results yield more
precise and statistically significant effects of domestic output
gaps on inflation, but the coefficients on foreign output gaps are
estimated to have the wrong sign--negative--and are generally
insignificant. Table 5b presents the analogous panel regressions
including speed limit effects, but the addition of these variables
does not materially change the results.

IV. The Role of the Domestic Output

Although we have been unable to find support for the view that
globalization has increased the role of foreign output gaps in
determining domestic inflation, this does not mean that
globalization might not have increased the role of foreign factors
and decreased the role of domestic factors through other channels.
In this section, we address the hypotheses that globalization has
led to a reduction in the sensitivity of inflation to domestic
output gaps. The following section assesses whether globalization
has boosted the sensitivity of inflation to import prices.

IV.1 Previous research

There is general agreement that in many industrial economies,
the responsiveness of inflation to domestic resource utilization
has declined-that is, the slope of the Phillips curve has become
flatter. This has been statistically examined by Roberts (2006) and
Hooper, Slok, and Dobridge (2006) for the United States, and by
Melick and Galati (2006), Borio and Filardo (2006), IMF (2006), and
Pain, Koske, and Sollie (2006), among others, for a range of
industrial economies.

The more open question is what has caused this decline in the
Phillips curve's slope. Dexter, Levi, and Nault (2005) argue that
once measures of trade are included in inflation equations for the
United States, measures of domestic slack regain their ability to
explain inflation in recent years. Roberts (2006) does not address
the issue of globalization, but argues that most or all of the
decline in the sensitivity of U.S. inflation to domestic resource
utilization can be attributed to improvements in the conduct of
monetary policy. Borio and Filardo (2006) and Pain, Koske, and
Sollie (2006) confirm a decline in the coefficient on the domestic
output gap across a wide range of OECD countries, but do not tie
this trend to changes in any indicator of globalization.

The IMF (2006) estimates panel regressions over the 1960-2004
period to explain annual inflation rates in eight industrial
economies. They allow the effect of domestic output on inflation to
vary over time by including interaction terms between the domestic
output gap and indicators of trade openness (measured as the share
of nonoil trade in GDP), monetary policy credibility, and labor
market rigidities. The coefficient on the openness interaction
variable is estimated to be negative and statistically significant
in most specifications of the model. Because trade shares have
risen over time, the authors conclude that declines in the
sensitivity of inflation to domestic output gaps owe importantly to
increases in trade openness.

Ball (2006), in his much simpler panel regression for the G7
countries over the 1971-2005 period, also includes an interaction
term between the domestic output gap and the share of trade in GDP.
He finds the coefficient on this term to be negative but small and
of only marginal statistical significance. In a study of European
countries, Mody and Ohnsorge (2006) also find that trade shares do
not significantly reduce the sensitivity of inflation to the output
gap, although larger trade shares apparently lower the pass-through
of domestic unit labor costs into domestic prices. Finally, Wynne
and Kersting (2007) estimate a very simple version of the Phillips
curve for many countries and find no relationship between its slope
and the import share.

IV.2 New results

In this section, we describe tests focused specifically on
gauging whether changes over time in the sensitivity of inflation
to domestic output gaps can be attributed to increases in trade
openness. The basis of these tests is the equation estimates shown
in Table 6. The first column for each country represents an
estimate of the same equation as shown in Table 3--which is
described by equation (5) in the text--but with two differences.
First, we have dropped the foreign output gap, which was not found
to be significant. Second, in order to focus on the more
fundamental behavior of inflation, we have replaced headline CPI
inflation (both the dependent variable and its lags) with core
inflation, which excludes movements in food and energy prices; we
continue to include food and energy prices in the equations to
capture second-round effects of their movements on core
inflation.12 Notably, these changes do not make a
great deal of difference to the basic results shown in Table 3.
Appendix Table 2 presents the analogous estimates using the
headline CPI inflation rates.

A key aspect of our analysis will be to examine changes in the
coefficients on the domestic gap and import prices over time.
However, because of the lags on inflation, import prices, food
prices, and energy prices, each equation involves the estimation of
26 coefficients. This limits the extent to which we can shrink the
sample size, which, in turn, limits the scope to assess changes in
parameter estimates over time. To conserve degrees of freedom, the
second column for each country reports the results of a restricted
version of the equation shown in the first column. The coefficients
on the first lag of inflation and the contemporaneous values of
import prices, food prices, and energy prices are unconstrained,
but the coefficients on the remaining lags of inflation and the
other price variables are constrained to be equal. (Equivalently,
for any of the price variables-e.g., import prices--the model
includes the contemporaneous value of the variable and an average
of the first through fifth lags of that variable.) For the most
part, the restricted equations produce similar results to the
unrestricted versions for the 1977-2005 sample.

The final two columns for each country present estimates over
the sub-samples 1977-1990 and 1991-2005. Consistent with prior
research and with the predictions of the globalization and
inflation hypothesis, the sensitivity of inflation to the domestic
output gap appears to have declined. Of the eight countries where
the coefficient on the output gap was estimated to be positive in
1977-90, that coefficient was smaller in the 1991-2005 sample in
six of those countries.

To elaborate on these results, Figure 1a depicts the estimates
of the coefficients on the domestic output gap based on rolling
regressions of the restricted equations shown in Table 6. Each
point represents the value of the coefficient from the equation
estimated over the preceding 10 years. The panels confirm that for
countries starting out with positive coefficients on the output
gap, these coefficients generally have declined on balance.

To what extent might these trends owe to globalization? Figure
2a looks at the relationship between the estimated coefficient on
the output gap and one measure of globalization--the share of trade
(exports plus imports) in total GDP. To the extent that
globalization reduces the sensitivity of inflation to the domestic
output gap, one might expect levels and changes in that sensitivity
to be negatively correlated with levels and changes in economic
openness. The top panel plots coefficients on the output gap for
different countries, estimated over the 1977-1990 period, against
average trade shares for those countries during the same period.
Excluding Belgium's nonsensical negative coefficient on the output
gap, there is no correlation to speak of. The middle panel, for the
1991-2005 period, hints at a negative correlation, but much of that
owes to the presence of many output gap coefficients that are,
again, negative and thus impossible to interpret. Finally, the
bottom panel plots changes in the output gap coefficient against
changes in the degree of openness. Excluding Belgium, there is, at
best, a hint of a negative relationship between the two series.

To formalize the casual empiricism embedded in Figure 2a, we
augment the equations reported in Table 6 by the following
additional explanatory variables, depicted in equation (7) below:
(1) the domestic output gap multiplied by the ratio of trade
(exports plus imports) to GDP; and (2) the import price variables
and their lags multiplied by the ratio of imports to GDP.13 If
globalization reduces the sensitivity of inflation to domestic
output gaps, then
should be negative. However, as
reported in Table 7, the estimates of this coefficient are rarely
statistically significant and of the appropriate sign.

(7)

tax
dummies,

where

= ( Export +
Import / GDP

= Import /
GDP

As in our discussion of the foreign output gap in Section III, it
may be the case that the influence of globalization on the
coefficients on the domestic output gap is too subtle to identify
in single-country equations. Accordingly, Table 8 presents
estimates of a panel regression version of the equations shown in
Table 7. The estimated coefficients on the interaction term between
the domestic output gap and the extent of trade openness are
generally negative, but the coefficients are small and not
statistically significant. More importantly, even after the
addition of the interaction terms as explanatory variables, the
coefficients on the domestic output gap decline substantially from
the 1977-90 sample to the 1991-2005 sample.

V. The Role of Import Prices

V.1 Previous research

The view that globalization is boosting the role of import
prices in domestic inflation is probably the least controversial
facet of the globalization hypothesis. Most directly, changes in
import prices will affect the prices of imported goods in the
consumption basket, so increases in the share of consumption that
is imported will naturally lead to the greater sensitivity of the
consumer price index to import prices. Additionally, movements in
import prices for particular products are likely to affect the
prices of similar products produced domestically.

The IMF (2006) study does not directly establish that domestic
inflation in the industrial countries it examines has become
increasingly sensitive to import prices. However, the inflation
equations it estimates for these countries include, in one variant,
an explanatory variable representing the change in the relative
price of aggregate imports multiplied by the ratio of imports to
GDP. The coefficient on this interaction term is, on average,
positive and significant, and with the share of imports generally
rising over the 1960-2004 period covered in the study, this
suggests that the impact of import prices on domestic inflation has
been rising as well. Nevertheless, the estimated effect is still
fairly small (about one-tenth of a change in import prices passes
through to overall inflation in the first year) and nearly
disappears after a couple of years.

Pain, Koske, and Sollie's (2006) study of 21 OECD countries
allows for import prices to affect domestic inflation in two ways.
First, the model includes changes in overall import prices. The
coefficients on these variables appear to be positive and
statistically significant, but no evidence is offered on whether
those coefficients have risen over time. Second, their model
includes a markup of price over cost, with higher markups leading
to lower subsequent inflation; costs are a weighted average of
domestic unit labor costs and import prices, with the weights
depending on the import share in domestic demand. The coefficient
on share-weighted import prices is found to be positive and
significant (and higher in the 1995-2005 period than in the
1980-1994 period), suggesting that increases in the share of
imports boost the weight of import prices in overall costs and
hence in prices. However, owing to the complexity of the
specification, it is unclear whether this result reflects an
increase in the sensitivity of inflation to import prices, a
decline in its sensitivity to domestic labor costs, or some other
factor.

Given our focus on the determinants of overall consumer price
inflation, the studies of aggregate import and consumer price
indexes described above are most relevant. It should be noted,
however, that linkages between import and domestic prices have also
been studied at a sectorally disaggregated level. Gamber and Hung
(2001) find that during the 1987-92 period in the United States,
domestic prices in particular sectoral categories were sensitive to
prices of imports in the same categories, and that sensitivity was
greater, the greater the import penetration of those sectors. The
IMF (2006) finds that in a range of industrial economies, prices in
particular manufacturing sectors relative to overall producer
prices are sensitive to import prices, and greater import
penetration in particular sectors leads to declines in the relative
rate of inflation; previously, Chen, Imbs, and Scott (2004) found
similar effects in a study of European manufactures prices. This
evidence of international linkages at the sectoral level does not
confirm a large and growing role for foreign developments in
domestic inflation. As stressed by Ball (2006), foreign shocks may
affect relative prices without altering the trajectory of overall
prices. Nevertheless, the evidence is suggestive of the growing
influence of foreign factors.14

V.2 New results

Here, we return to the econometric results shown in Table 6 and
focus on the sum of the estimated coefficients on changes in import
prices. Surprisingly, comparing the results for the 1977-1990
period with those for the 1991-2005 period, there is no evidence of
a generalized increase in the sensitivity of inflation to import
prices; the coefficient on import prices increased in only four of
the ten countries--one of them being the United States--where data
existed for both samples. The rolling regression results shown in
Figure 1b confirm the lack of a systematic uptrend in coefficients
on import prices.

Figure 2b addresses the relationship between the estimated
coefficients on import prices and the extent of trade openness,
this time as measured by the ratio of imports to GDP. In principle,
higher ratios of imports to GDP should be associated with higher
sensitivities of inflation to import prices. The top panel, for the
1977-90 period, provides some support for this hypothesis, although
the apparent correlation is driven by an outlier, Belgium. The
middle panel suggests that such a relationship, if there ever was
one, broke down in the later 1991-1995 period. Finally, the bottom
panel suggests that increases in import shares between the two
periods led to reductions in the coefficient on import prices, an
apparent contradiction of the globalization and inflation
hypothesis.

As noted in Section IV, the country-specific inflation equations
in Table 7 include an interaction term between import price
inflation (and its lags) and the ratio of imports to GDP. As would
be expected, given the findings discussed above, the estimated
coefficients on this term are rarely positive and significant, as
would be predicted by the inflation and globalization
hypothesis.

Finally, we return to the panel regression estimates shown in
Table 8. Unlike in some of the country-specific equations, the
coefficient on import price inflation is estimated to be positive,
albeit not significant, and to rise between the 1977-1990 and
1991-2005 periods, consistent with the globalization hypothesis.
The coefficient on the interaction term between import price
inflation and the import share in GDP term is positive (at least
for the full sample and earlier sub-sample), but it is usually not
significant. Moreover, even with the inclusion of the interaction
term, the estimated coefficient on import prices moves up between
the 1977-1990 and 1991-2005 sub-samples.

One potential problem with the estimates shown in Table 8 is
multicollinearity resulting from the presence of both six import
price inflation terms (contemporaneous plus five lags) and six
additional interaction variables between the import share and those
import price terms. Accordingly, Table 9 shows estimates of
equations where the variables for import price inflation alone have
been dropped. In the estimates for the entire 1977-2005 period, the
coefficients on the import interaction terms are now statistically
significant, indicating that higher import shares raise the effect
of import prices on inflation. However, at around 0.1, the
coefficients are extremely small; they suggest that if the ratio of
imports to GDP is 20 percent, a rise in import price inflation of 1
percentage point boosts inflation by only 0.02 percentage
point.

To conclude, we find only weak evidence that import prices
significantly affect CPI inflation, that this effect has been
rising over time, and that this rise owes to increases in trade
openness. These findings are surprising, as we would expect that
increases in trade should render inflation more sensitive to import
prices. A plausible explanation for these findings is that in the
1991-2005 period, as inflation throughout the industrial economies
became less variable and generally subject to fewer large shocks,
it may have become harder to identify econometrically the effects
of import prices. Indeed, one reason that inflation has become less
variable may be that improvements in monetary policy have led to
better-anchored inflation expectations; in addition to reducing the
variability of inflation, improved policy may have led inflation to
become generally less sensitive to shocks (Roberts, 2006, Kroszner,
2007, and Mishkin, 2007). Finally, the process of trade integration
has been ongoing for much longer than the past 15 years, and hence
a longer period than we are studying may be required to identify
its evolving impact on inflation.

VI. The stabilizing role of net exports in open
economies

Although we have found scant evidence that globalization is
responsible for changes in the parameters of the inflation process
in industrial economies, there is another channel through which
globalization could influence inflation behavior. As the share of
trade in GDP rises, it is plausible that variations in real net
exports may become more important in the evolution of real GDP.
Moreover, as many observers have suggested, financial
globalization also could lead to greater variation in net exports
by allowing larger trade imbalances to be financed. Thus, real net
exports increasingly could act as a buffer between domestic demand
and GDP, declining as increases in domestic demand boost imports
and falling as domestic demand eases. This would tend to stabilize
GDP and the output gap, thereby stabilizing inflation as well. As
Kohn (2006) notes, ``a more open economy may be more forgiving as
shortfalls or excesses in demand are partly absorbed by other
countries through adjustments in our imports and exports.''

Some evidence in favor of this hypothesis is presented in Figure
3, which shows that over time, the correlation between real
domestic demand and real GDP has been trending down in many
industrial economies. Figure 4 compares the trend over time in the
absolute value of the share of net exports in GDP, calculated as a
rolling 10-year moving average over the sample period. In most
countries, the size of net exports has been rising relative to that
of GDP, suggesting a looser relationship between domestic demand
and GDP than has prevailed in the past. In the United States, the
large deficit on net exports has allowed domestic demand to far
exceed both actual and potential GDP. In the absence of this
deficit, either domestic demand would have to be considerably
restrained or the output gap would become unacceptably large.

Finally, Figure 5 presents the trend over time in the covariance
between the contributions of domestic demand to real GDP growth and
the contributions of net exports. Consistent with a stabilizing
role for net exports, this covariance is generally negative,
suggesting that movements in domestic demand are offset by changes
in net exports. These covariances do not appear to be trending more
negative over time, as might be suggested by on-going
globalization, but they are quite volatile and this may be
obscuring longer term trends.

VII. Conclusion

This paper describes research to evaluate the hypothesis that
globalization has increased the role of international factors and
decreased the role of domestic factors in the inflation process in
industrial economies. Toward that end, we estimated standard
Phillips curve inflation equations for 11 industrial countries and
used these estimates to test several predictions of the
globalization and inflation hypothesis.

By and large, our findings suggested that the evidence for that
hypothesis is surprisingly weak. First, the estimated effect of
foreign output gaps on domestic consumer price inflation was
generally insignificant and often of the wrong sign. Second,
although we replicated earlier findings that the sensitivity of
inflation to the domestic output gap has declined over time in many
of these countries, we found no conclusive evidence that this
decline owed to globalization. The countries where the role of the
output gap declined the most were not those where openness to trade
had increased the most, nor did measures of trade openness
significantly affect the sensitivity of inflation to output gaps in
our econometric equations. Finally, our econometric results
provided, at best, only weak evidence that the responsiveness of
inflation to import prices has been important, has increased over
time, and has been influenced by increases in trade openness.

As economies around the world are increasingly tied together by
trade and other economic linkages, it is plausible that foreign
developments should play an increasingly important role in
determining domestic inflation. Accordingly, we were surprised by
the weakness of the evidence for the globalization and inflation
hypothesis. Our results may be telling the truth: that inflation
has not become as globalized as some observers would assert. For
example, structural rigidities in some economies may be impeding
the response of the price setting process to globalization.

However, it is also possible that international conditions are
becoming more important to the inflation process, but it is
difficult to discern this effect in the data. In particular, as
inflation throughout the industrial economies has in recent years
become less variable and subject to fewer large shocks, it may have
become harder to identify econometrically the effects of foreign
developments on inflation. Indeed, to the extent that monetary
policy has succeeded in better anchoring inflation expectations in
recent years, this may have led inflation to become both less
variable and less sensitive to resource utilization and relative
prices, potentially offsetting the effects of globalization.
Finally, the process of trade integration has been ongoing for much
longer than the past 15 years; therefore, it is entirely possible
that the impact of globalization has not been confined just to that
most recent decade and a half, and a longer period than we have
studied may be required to identify its evolving impact on
inflation. In any event, more research in this area is
indicated.

Although we did not find evidence that globalization had altered
the parameters of the inflation process, we did uncover indications
that globalization had affected one of the inputs into that
process, the output gap. Over time, net exports appear increasingly
to have attenuated the linkage between domestic demand and real
GDP--the correlation between the two has declined in most
industrial economies, and net exports have generally become larger
as a share of GDP. This suggests that net exports have either
helped to stabilize real GDP, output gaps, and inflation for given
trajectories of domestic demand or, alternatively, have allowed
domestic demand to fluctuate more widely without destabilizing GDP
and inflation in the process.

Papademos, Lucas (2006), ``Monetary Policy in a Changing World:
Commitment,
Strategy, and Credibility,'' Speech at Fourth Conference of the
International
Research Forum on Monetary Policy,'' Washington, D.C., December
1.

Yellen, Janet (2006), ``Monetary Policy in a Global
Environment,'' Speech at the
Conference ``The Euro and the Dollar in a Globalized
Economy,''
University of California at Santa Cruz, Santa Cruz, CA, May.

* Borio and Filardo (2006) Table 3. Sample end dates range from 2005Q2 to 2005Q4.
** P-level for the hypothesis that the coefficients of an AR(4) for the residual are jointly equal to zero. If value is less than 0.05, then reject hypothesis of serial independence.

* Borio and Filardo (2006) Table 4. Sample end dates range from 2005Q2 to 2005Q4.
** P-level for the hypothesis that the coefficients of an AR(4) for the residual are jointly equal to zero. If value is less than 0.05, then reject hypothesis of serial independence.

* Inflation is measured as the annualized quarterly percent change in the seasonally adjusted CPI excluding food and energy; equation includes constant and tax dummies (not shown)
** Australia energy price data begins in 1991
*** Coefficients on second through sixth lags of inflation and first through the fifth lag of import, food, and energy prices are constrained to be equal
**** Annualized quarterly percent change, difference from lagged core CPI inflation
*****Inflation based on BLS current-methods CPI excluding food and energy
Normality: Jarque-Bera test
Serial Independence: Test of the hypothesis that all the coefficients in an AR(4) for the residuals are equal to zero
ARCH 1-4: Test of conditional homoskedasticity

Table 7: Core Inflation and Openness*

Australia: Unrestricted: 77-05*

Australia: Restricted**: 77-05

Australia: Restricted**: 77-90

Australia: Restricted**: 91-05

Belgium: Unrestricted: 77-05

Belgium: Restricted**: 77-05

Belgium: Restricted**: 77-90

Belgium: Restricted**: 91-05

Canada: Unrestricted: 77-05

Canada: Restricted**: 77-05

Canada: Restricted**: 77-90

Canada: Restricted**: 91-05

France: Unrestricted: 77-05

France: Restricted**: 77-05

France: Restricted**: 77-90

France: Restricted**: 91-05

Italy: Unrestricted: 77-05

Italy: Restricted**: 77-05

Italy: Restricted**: 77-90

Italy: Restricted**: 91-05

Japan: Unrestricted: 77-05

Japan: Restricted**: 77-05

Japan: Restricted**: 77-90

Japan: Restricted**: 91-05

Netherlands: Unrestricted: 77-05

Netherlands: Restricted**: 77-05

Netherlands: Restricted**: 77-90

Netherlands: Restricted**: 91-05

Sweden: Unrestricted: 77-05

Sweden: Restricted**: 77-05

Sweden: Restricted**: 77-90

Sweden: Restricted**: 91-05

Switzerland: Unrestricted: 77-05

Switzerland: Restricted**: 77-05

Switzerland: Restricted**: 77-90

Switzerland: Restricted**: 91-05

UK: Unrestricted: 77-05

UK: Restricted**: 77-05

UK: Restricted**: 77-90

UK: Restricted**: 91-05

US: Unrestricted: 77-05

US: Restricted: 77-05

US: Restricted: 77-90

US: Restricted: 91-05

Lagged inflation,
sum:

0.612

-

-

0.655

0.865

0.860

0.411

0.551

0.959

0.951

1.080

0.058

0.9887

0.9966

1.0068

1.2405

1.0152

0.9933

1.0120

0.9732

0.8299

0.7837

0.7065

0.5570

0.9129

0.8589

0.7009

0.3334

0.9399

0.9276

-0.0932

0.5845

1.0158

0.9943

0.9022

1.2580

0.9135

0.9144

0.8323

0.1625

0.9849

0.9903

0.8960

0.7919

Lagged inflation,
sum: SE

0.332

-

-

0.239

0.065

0.156

0.207

0.429

0.039

0.111

0.273

0.296

0.0224

0.1108

0.1574

0.2803

0.0298

0.1496

0.2458

0.2593

0.0502

0.1036

0.1781

0.1885

0.0890

0.1483

0.2690

0.3585

0.0576

0.1317

0.2757

0.1985

0.0504

0.1370

0.2294

0.2266

0.0679

0.1410

0.2008

0.3449

0.0394

0.1377

0.2330

0.2598

Domestic Output Gap:

-0.144

-

-

0.480

0.198

0.561

4.521

3.185

0.761

0.683

3.470

-1.741

0.1019

0.4983

-0.1885

-0.6518

0.0924

0.3020

-3.1047

0.9211

1.2193

1.1398

1.1401

1.2078

0.7162

0.8034

1.9883

0.6436

0.5189

0.6746

-4.9829

-1.0516

1.4488

1.4440

3.7507

-1.3003

1.3904

1.9163

4.0605

-0.4312

0.1029

0.0884

-0.1614

-0.8233

Domestic Output Gap: SE

1.626

-

-

1.265

1.404

1.364

2.716

1.945

0.274

0.269

1.445

0.868

0.7237

0.6766

1.1737

1.2543

0.7738

0.8472

1.9059

0.8941

0.3872

0.3415

0.5321

0.6275

0.5502

0.5388

2.2865

0.7039

0.6173

0.6392

2.2346

0.7750

0.7265

0.7261

1.9268

1.2802

1.6912

1.6588

2.6549

2.5032

0.3423

0.3262

1.4636

1.1803

Domestic Output Gap x
Openness+:

0.319

-

-

-1.342

-0.293

-0.595

-3.997

-2.301

-0.860

-0.717

-6.161

2.596

0.2015

-0.5716

1.1576

1.5209

0.0795

-0.1506

7.9110

-1.8865

-5.8662

-5.5422

-5.5290

-5.2579

-0.5103

-0.6167

-1.7391

-0.4812

-0.5174

-0.7155

8.1825

1.3494

-1.7377

-1.7782

-4.9260

1.2645

-2.1422

-3.2824

-6.9528

0.5946

0.1129

0.2437

1.7910

4.1776

Domestic Output Gap x
Openness+: SE

4.204

-

-

3.351

1.035

1.011

2.140

1.399

0.462

0.465

2.787

1.209

1.5786

1.4819

2.5917

2.6552

1.6859

1.8503

4.2749

1.7290

1.8316

1.6209

2.3788

3.0321

0.4646

0.4589

2.0842

0.5671

0.9210

0.9589

3.4722

0.9729

0.9812

0.9970

2.7751

1.5993

3.2610

3.1885

5.0301

4.8299

1.6081

1.5466

7.8148

4.9015

Import price, sum***:

-0.147

-

-

1.430

0.153

-0.146

-0.618

-2.550

0.336

0.300

-0.371

-0.090

0.0463

-0.0642

0.2496

-0.0067

-0.0562

-0.0154

-0.6681

0.3595

-0.1885

-0.2232

-0.2477

-0.2657

0.4577

-0.5212

0.6395

-1.9076

0.0716

-0.2304

-2.3274

-0.2778

-0.0149

-0.1207

0.2527

-0.8097

-0.0480

0.1733

-0.7490

-1.1547

-0.0045

-0.0012

-0.1451

0.2819

Import price, sum***: SE

0.783

-

-

0.607

0.401

0.348

0.466

0.856

0.178

0.202

1.157

0.395

0.3998

0.3389

0.6626

0.5660

0.2498

0.2535

0.5273

0.2635

0.0723

0.0555

0.0833

0.1719

0.5383

0.5042

1.3887

0.6327

0.3785

0.3884

1.0779

0.4741

0.3051

0.3226

0.5270

0.4988

0.7004

0.7603

1.1134

1.8704

0.1661

0.1930

1.1107

0.3063

Import price x Import
Share, sum***++:

0.492

-

-

-6.882

-0.147

0.320

1.192

3.297

-0.656

-0.532

1.889

0.153

-0.2272

0.0647

-1.1940

-0.0454

0.3758

0.2156

3.5593

-1.1436

2.1426

2.6212

2.8548

2.8771

-0.7647

1.0615

-1.0672

3.4135

-0.0317

1.0450

7.5454

0.9020

0.2651

0.5632

-0.5520

2.6997

0.0645

-0.7193

3.2026

3.4251

0.2459

0.2119

1.8442

-1.3542

Import price x Import
Share, sum***++: SE

3.739

-

-

2.913

0.607

0.515

0.719

1.119

0.555

0.621

4.527

1.097

1.6819

1.4558

2.9434

2.2781

1.1337

1.1514

2.5584

1.1351

0.7269

0.5295

0.7751

1.9173

0.9748

0.9320

2.5925

1.1139

1.1948

1.2059

3.4882

1.3313

0.9107

0.9678

1.5616

1.5006

2.5436

2.8532

4.3015

6.7291

1.4554

1.7172

10.7185

2.3223

Food price, sum***:

0.209

-

-

0.183

0.044

0.101

0.219

0.521

-0.079

-0.065

-0.089

0.293

0.0646

0.1227

0.0265

0.3358

0.2874

0.2385

0.1964

0.2263

0.0355

0.0847

0.1510

0.1030

0.0758

0.1369

0.0064

0.2242

0.0814

0.0600

0.7520

0.2044

0.1177

0.1271

0.0563

0.5118

0.4902

0.3484

0.6688

0.2269

0.0567

0.0852

-0.0093

0.2176

Food price, sum***: SE

0.464

-

-

0.268

0.069

0.075

0.086

0.209

0.060

0.059

0.089

0.130

0.0666

0.0693

0.1361

0.1007

0.1069

0.1262

0.2887

0.1265

0.0742

0.0653

0.1847

0.0602

0.0825

0.0710

0.1910

0.0955

0.0826

0.0890

0.2290

0.1655

0.0429

0.0457

0.0555

0.1445

0.2089

0.1808

0.2840

0.2402

0.0626

0.00549

0.1178

0.0760

Energy price, sum***:

-0.026

-

-

-0.046

0.046

0.043

0.026

0.053

0.039

0.029

0.009

-0.073

-0.0024

-0.0132

-0.0182

0.0054

-0.0303

-0.0316

0.0618

0.0104

0.0173

-0.0167

-0.0214

0.0047

0.0085

0.0189

0.0512

0.0178

0.0426

0.0702

0.2481

0.0060

0.0003

0.0002

0.0126

-0.0151

0.1009

0.1024

0.3546

0.1261

0.0210

0.0226

0.0512

-0.0205

Energy price, sum***: SE

0.116

-

-

0.070

0.021

0.022

0.022

0.051

0.022

0.022

0.040

0.035

0.0184

0.0181

0.0323

0.0304

0.0272

0.0315

0.0662

0.0350

0.0209

0.0207

0.0330

0.0479

0.0211

0.0223

0.0532

0.0371

0.0366

0.0344

0.0576

0.0589

0.0101

0.0102

0.0111

0.0260

0.0616

0.0631

0.1131

0.0848

0.0099

0.0094

0.0217

0.0135

Adj R2:

0.585

-

-

0.647

0.722

0.709

0.837

0.293

0.902

0.889

0.828

0.789

0.9628

0.9597

0.9489

0.6371

0.9471

0.9308

0.9094

0.7360

0.8389

0.8399

0.7194

0.7983

0.5965

0.5966

0.5891

0.4525

0.8286

0.8015

0.7013

0.7971

0.8758

0.8582

0.8532

0.8292

0.8001

0.7831

0.7977

0.2298

0.9084

0.9111

0.8290

0.5461

Adj R2: SER

1.474

-

-

1.359

1.115

1.141

0.809

1.162

0.979

1.044

1.066

0.857

0.7206

0.7508

0.8228

0.5931

1.2289

1.4058

1.5781

0.8382

0.7829

0.7806

0.8766

0.5821

1.0299

1.0299

1.3013

0.7781

1.7196

1.8507

1.6127

1.4099

0.6919

0.7395

0.6430

0.7581

1.9155

1.9957

2.1092

1.2370

0.6317

0.6226

0.7812

0.4281

Normality

0.699

-

-

0.841

0.062

0.000

0.111

0.000

0.830

0.804

0.270

0.029

0.1012

0.0032

0.5071

0.0044

0.0007

0.0000

0.1398

0.3679

0.0392

0.0346

0.1819

0.9438

0.4757

0.0115

0.2165

0.4613

0.5152

0.2100

0.4883

0.0001

0.0569

0.0123

0.0043

0.3665

0.0118

0.0099

0.5229

0.4094

0.1614

0.0000

0.2840

0.2276

Serial Independence

0.006

-

-

0.164

0.156

0.453

0.057

0.950

0.751

0.892

0.679

0.402

0.5565

0.0329

0.4993

0.0250

0.1810

0.0927

0.8400

0.6813

0.8465

0.4329

0.2703

0.7363

0.0079

0.2749

0.6580

0.8833

0.6572

0.0611

0.2259

0.0642

0.1191

0.0066

0.2953

0.2319

0.3714

0.0488

0.0823

0.1549

0.0224

0.2550

0.0657

0.2933

ARCH 1-4

0.824

-

-

0.657

0.277

0.221

0.903

0.587

0.042

0.135

0.547

0.890

0.4239

0.5281

0.2664

0.7014

0.1011

0.0068

0.3032

0.7535

0.9870

0.4207

0.7444

0.1889

0.9631

0.5164

0.9415

0.8158

0.3800

0.7807

0.4918

0.9758

0.9754

0.9630

0.7453

0.9864

0.9543

0.8110

0.8901

0.5330

0.6133

0.0188

0.5199

0.1952

Australia energy price data begins in 1991
Inflation based on BLS current-method CPI excluding food and energy
* Inflation is measured as the annualized quarterly percent change in the seasonally adjusted core CPI; equation includes constant and tax dummies (not shown)
** Coefficients on second through sixth lags of inflation and first through fifth lags of import, food and energy prices are constrained to be equal
*** Annualized quarterly percent change, difference from lagged core CPI inflation
+ Openness is measured as a 4-quarter moving average of nominal exports plus nominal imports divided by nominal GDP.
++ Import share is measured as a 4-quarter moving average of nominal imports divided by nominal GDP.
Normality: Jarque-Bera test
Serial Independence: Test of the hypothesis that all the coefficients in an AR(4) for the residuals are equal to zero
ARCH 1-4: Test of conditional homoskedasticity

Footnotes

* The views in this paper are solely the responsibility of the authors and should not be interpreted as reflecting the views of the Board of Governors of the Federal Reserve System or of any other person associated with the Federal Reserve System. We thank Steve Cecchetti, Joseph Gagnon, Peter Hooper, Michael Leahy, Sylvain Leduc, Ellen Meade, John Roberts, Torsten Slok, and Mark Wynne, as well as participants in workshops at American University and the Federal Reserve Board for useful comments. Sean Fahle, Stephen Gardner, and Jonas Robison provided excellent research assistance. Return to text

1. See also Fisher and Cox (2007). Charles
Bean, Executive Director, Chief Economist, and member of the
Monetary Policy Committee of the Bank of England, also attributes
significant changes in inflation behavior to globalization. (Bean,
2006) Return to text

4. There is no consensus on exactly how to
measure the effect on industrial-country inflation of the
integration of China and other low-wage economies into the world
economy. Most studies suggest that this process has lowered
inflation in the United States and other industrial economies by a
non-negligible, but reasonably modest, extent. However, the
depressive effect of China and other low-wage countries on prices
of manufactures may have been offset, to an uncertain extent, by
these countries' role in boosting demand and prices of primary
commodities. See Hooper, Spencer, and Slok (2007), Kamin, Marazzi,
and Schindler (2006), Kohn (2006), Pain, Koske, and Sollie (2006),
and Yellen (2006), among others. Return
to text

5. For example, assessing the ``China
effect'' typically involves gauging the effects of trade with
developing countries on the evolution of import prices, whereas
assessing the effect of globalization more generally on the
inflation process typically involves tests of the structural
stability of inflation equations for industrial
economies. Return to text

6. Equation (1) represents a conventional
Phillips curve model, and the research described in this paper
stays within this framework throughout. There have also been some
analyses of open-economy influences on inflation using a ``New
Keynesian'' Phillips curve framework, including Clarida, Gali, and
Gertler (2002), Andres, Ortega, and Valles (2003), and Monacelli
(2003). Return to text

7. Of course, consumer prices are composed
of both goods and services whereas imports are primarily goods. As
a result, changes in import prices may deviate on average from
consumer price inflation, which will be reflected in the constant
in empirical work. Return to text

8. This premise contradicts Rogoff's (2003)
argument that globalization, by causing prices to be more flexible,
has led inflation to become more sensitive to domestic resource
utilization. That implies a steeper Phillips curve than in the
past, a prediction that, as will be discussed below, is
contradicted by most empirical studies. Return to text

9. Gust and Marquez (2002) document that
productivity growth in many industrialized countries stayed flat or
declined in the 1990s. Return to
text

10. We calculate the foreign output gap for
the United States as a time-varying weighted average of the output
gaps of a fixed group of 35 trading partners, with the weights
based on annual U.S. bilateral imports from and exports to those
countries along with measures of competition in third-party
markets; we calculate foreign output gaps for the remaining 13
countries in the sample analogously using those countries' weights.
By contrast, the BIS estimates of the foreign output gap involve
only a country's top 10 trading partners for a given year, and use
only bilateral measures of trade and other transactions for the
weights; the set of trading partners may change from year to year
as the composition of the top 10 changes. Return to text

11. The test consists of regressing
residuals on their lagged values and then testing whether the
coefficients on those lags are jointly equal to zero. Return to text

12. This specification is broadly similar
to that described in Stockton (1985), except that our specification
incorporates changes in relative import prices as
well. Return to text

13. In the unrestricted version of
equation (7), for the interaction term, each lag of the relative
import price term is multiplied by the same lag of the import
share; for the restricted version, the moving average of relative
prices is multiplied by the contemporaneous import
share. Return to text

14. Using a much less structural approach,
Ciccarelli and Mojon (2006) identify common factors in inflation
among OECD countries and find that those factors explain a large
share of the variance in national inflation rates. Return to text